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I think of Seagate Technology plc (STX) as a weaker link the storage industry because of its revenues growth. Since the last time that I wrote about the company, the share price is pretty much flat at $50 per share.

STX Revenue (<a href=

STX Revenue (TTM) data by YCharts

Since that time, Seagate reported an EPS decline of 19% in the first fiscal quarter relative to the year-ago quarter. I think that this is a trend that is likely to continue throughout the fiscal year as Seagate reported 2013 EPS above normalized EPS. Additionally, I think the median EPS estimate for fiscal 2014 is too high as first quarter EPS declined 19% and second quarter totaled revenue is forecasted by management to be flat. Thus, the back half of 2014 would have to be exceptionally strong for Seagate to meet the current forecast.

I continue to think of Seagate as a short sale candidate; I am waiting for a catalyst to get short shares. My intrinsic value estimate is $46.83, but I could lower it to $40 following second quarter earnings.

Recent Developments

  • Seagate introduced the Business Storage Windows Server ("BSWS") 4-bay NAS. Truthfully, I'm disappointed that the BSWS is running HDDs instead of SSHDs.

  • The company announced that it has been named an International CES Innovations 2014 Design and Engineering Awards Honoree for its Business Storage 8-bay rackmount NAS solution.

  • Seagate announced that it is shipping the new 2.5-inch Spinpoint M9T, which at 9.5 mm thin is the world's thinnest 2TB hard drive.

  • Seagate sold $800 million of senior unsecured notes at an interest rate of 3.75% per annum.

Fundamental Analysis

From a product perspective, management is focused on generating revenues from SSD and shingled magnetic recording technology. This is as unit shipments flatten and exabytes grow. I think the consumer PC market will remain weak and dampen demand for HDDs, but the enterprise storage market will offset some of that weakness.

STX EPS Diluted (Quarterly YoY Growth) Chart

STX EPS Diluted (Quarterly YoY Growth) data by YCharts

Seagate's management is expecting fiscal Q2 revenues in the $3.5 billion to $3.6 billion range; this compares with revenues of $3.67 billion in the year-ago quarter. The revenues forecast suggests to me that I am being too generous with the company's intrinsic value estimate, but I will maintain my EPS forecast of $5.26 for now. A hypothetical alternative intrinsic value estimate would be closer to $40 per share.

For fiscal 2014, I'm forecasting revenues between $11.11 billion and $15.21 billion, which is an expanded range relative to my previous forecast. The difference is attributable to the model inputs. The low end of the range is 22.6% below fiscal 2013 revenue, which is attributable to forecasting confidence. On the other hand, revenues could increase 6% or more next fiscal year.

In fiscal 2016, I'm forecasting revenues between $12.3 billion and $16.8 billion. The fiscal 2014 and fiscal 2016 forecasts will be dependent on the results of the Client Compute segment. On the low end, revenues would decline at a CAGR of 5%; the high end suggests a CAGR of 5.4%.

All else equal, the share price downside should be limited by the share repurchase program: a revenues decline may not have a severe adverse impact on the share price of Seagate.

Overall, Seagate returned too much capital to shareholders in previous years and did not strengthen its competitive position enough, which resulted in sub-competitive revenues growth. I think of Seagate as a weaker link in the storage industry chain.

Valuation

I'm going to use the multiplier model to value the common equity shares of Seagate. I'll use Seagate's 5-year average P/E and the S&P 500 as benchmarks. The S&P 500 valuation suggests Seagate is undervalued. But the company's EPS forecast could be revised lower during the fiscal year; consequently, relative to its 5-year average, Seagate is overvalued. If the share price rises above $52 and there is a short sale catalyst, Seagate is a short sale candidate.

According to The Fed Model, the justified P/E for the S&P 500 is 35.34. The forward P/E for the S&P 500 is 16.5. Thus, The Fed Model suggests that the S&P 500 is currently undervalued by 114%; this means that I'm not comparing Seagate to an overvalued asset. I estimate that Seagate is trading at 9.67 times next twelve months earnings; Seagate is 70.6% undervalued relative to the S&P 500 on a forward basis.

STX PE Ratio (<a href=

STX PE Ratio (TTM) data by YCharts

The 5-year average price to earnings ratio is 8.1 and the current P/E is 11. The premium that investors are paying for earnings of Seagate is partly attributable to the decrease in financial risk. Consequently, for use in my estimate, I'm subjectively revising the 5-year average P/E upward by 10% to 8.91 because of the decrease in leverage.

For fiscal 2014 and 2015 respectively, the median Wall Street EPS forecasts are $5.36 and $5.86. I'm lowering the forecast to account for first quarter results; thus, my forward EPS is $5.26. In other words, I think the median forecast will be revised lower. Using the adjusted 5-year average P/E, I estimate the intrinsic value as $46.83, which means that Seagate is overvalued at $50.89 per share. But I don't think that the mispricing, if present, is large enough for investment purposes.

If Seagate continues to trade higher and we get a catalyst for selling, Seagate is a short sale candidate at $52 per share and above.

Source: Seagate Remains A Weak Link In Electronic Storage